How Pension Plans Work - a Simple Explanation

A pension is a way to save for retirement. Like most retirement plants, there are tax benefits to pension plans. Once you retire from work, your pension will pay you on a regular schedule for the remainder of your life. Due to changes in 2006, pensions are more flexible and straightforward than they have been in the past. There are three primary types of pension funds, and you may be eligible for all three. The types are: state, company and personal.

State Pension Funds

Your state pension fund will be determined based on the amount of National Insurance contributions you made during your lifetime. You will be eligible to start receiving the funds at 65 for men, or 60 for women, if you were born before 1950. Women born after 1950 will be treated the same as men, receiving pension eligibility at 65. This age increases even more in 2024, when people will not receive their pensions until the age of 68.

Company Pensions

Your employer may offer a pension option as part of your benefit package. Similar to a 401k option, your employer may offer to match your contributions. This type of pension is called a "money purchase scheme." With the other option, a "salary scheme," your employer may offer to pay out your pension based on the salary you earned in your time with the company. You will have a pension plan administrator, and this person may be contacted to assist you in better understanding the pension program your employer offers including how much you should pay, how much you will receive and when you will receive the money.

Personal Pensions

Your personal pension fund may be administered by a bank, insurance company or other joint investment group. These financial administrators will accept your funds, invest them, and keep you updated on their growth. When you reach the age of 50, you will begin receiving payments from a personal pension fund. Depending on the service you use, your pension scheme will be handled in any number of ways while your funds are invested. If your employer does not offer a company pension, you may inquire about any personal pension funds you may have access to through them. For example, even if they do not match or assist you in financial planning, your company may offer the opportunity to sign up with an administrator they recommend for their employees.

Tax Benefits for Pensions

The IRS allows you to make contributions to your pension on a tax-free basis. This means the funds you would have paid in taxes for the amount you are contributing go to the pension fund instead. The IRS offers this incentive to encourage savings. Retired persons can become a burden on the federal and state government if they do not have the funds to continue to care for themselves later in life. As life expectancy increases, the date when you can begin withdrawing increases as well. This ensures you will have enough money left for your retirement.